Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Which specific funds have investors been buying and selling? Joining me to discuss some of the big ones is Russ Kinnel--he is director of fund research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Good to be here.

Benz: Russ, in your cover story for Morningstar FundInvestor, you took a look at what you call the most heavily traded funds in the U.S.--funds that have been seeing big inflows as well as outflows. I was hoping you could start by doing a little bit of stage-setting. When you see dramatic inflows or outflows from a given fund, does that set off alarm bells in any way? Does it hinder managers' tasks?

Kinnel: A little bit. Certainly, we want to really look closely at a fund that's getting either big inflows or outflows. It means not only that there are challenges for the managers making all those trades, but also it means there are going to be some big effects on the organization as a whole. Either they are going to be ramping up in people or, if they are getting redemptions, they may be cutting--or at least there are going to be some big changes. So, you want to take a close look; but also we know that a lot of our Morningstar readers are going to have these funds on their minds, which is why I wanted to talk about a lot of these funds with the really big inflows and outflows.

Benz: So, let's start with the outflows. We want to touch on PIMCO because that's been a big story in the realm of outflows, but let's start with an equity fund that is near the top of the list in terms of outflows--that's Fidelity Contrafund (FCNTX). Let's talk about what's going on there.

Kinnel: That's right. Contrafund has been run by Will Danoff for a very long time, but it's had some outflows. Now, I believe some of that is CIT conversion, which is similar to a mutual fund construct but not quite the same. It costs a little less. Some 401(k)s are opting to convert to CIT. So, some of that outflow number may actually not be outflows but just conversion into another vehicle.

Benz: So, people like Danoff's style, maybe they want to stick with it, but they want to hold it in this collective-investment-trust form.

Kinnel: That's right. The downside with those is that there's a little less regulation, a little less clarity and openness on those funds. But the bottom line is whether it's actual redemptions or CIT conversions, it's not a huge part of Contrafund and it holds very liquid large-cap stocks. So, I don't see that as having an impact on the fund in a big way. Will Danoff is still a great investor. The three-year returns have been OK, but the long-term [returns are] great. We rate the fund Silver. I still have a lot of confidence in it. So, this is one fund with outflows that I would definitely hold on to if I owned it.

Benz: So, it's one of the better core equity funds from Fidelity, certainly.

Kinnel: Yeah. Will Danoff has an absolutely amazing record; [he has done an] amazing job of running a huge sum of money.

Benz: Let's turn to this PIMCO story, Russ. We have seen significant redemptions, obviously, from PIMCO Total Return (PTTRX), which had been the flagship and was affected by Bill Gross' departure; but we've also seen other PIMCO funds experience big redemptions. Let's talk about that story and also where we currently have these funds in terms of the ratings.

Kinnel: PIMCO Total Return is unprecedented in so many ways--$120 billion or so of outflows in the last year. We have never seen anything like it. In a way, it's kind of a lab for outflows in a pretty high-quality intermediate-bond fund. Generally, the rule is you don't think flows will have a big impact and, remarkably, they haven't in this case. The fund has actually been a very strong performer. We don't see a lot of evidence that outflows have hurt it, and we rate it a Bronze. We recently reaffirmed that. We see a lot of good things with the new management team. We like the inflows of people, even if there are huge outflows of money. So, a lot of good things to see, but we want to see things continue to stabilize. We want to see how the team works together. But so far, so good.

Benz: One of the things I know people have been watching for in the context of PIMCO Total Return was whether these investor outflows would cause sort of an avalanche effect. If you were left in the fund, the fund may have to be selling things that it would rather hang on to. How has PIMCO Total Return managed to navigate that?

Kinnel: Well, the fund had been in redemptions even before Gross left, and it had had a lot in cash or cash-like securities, so it was able to manage it pretty well. Also, a lot of the bigger clients who are coming out are giving PIMCO notice months in advance. So, again, the managers know to keep a fair amount in liquid securities, so they've maintained a big cash stake. And so, that has meant, as outflows come in, they meet those with some cash but also they are selling off the rest of the portfolio, so it doesn't leave them one day painted into a corner with no cash. They are maintaining their cash. They've managed it quite well, really.

Benz: PIMCO Unconstrained Bond (PUBAX) is another fund that saw redemptions in the wake of Gross' departure, but it, too, had been seeing redemptions even before that.

Kinnel: It had disappointing performance, but also three manager changes in the space of about two years. So, we are not really enthused about it. We rate it as Neutral. Also, the unconstrained strategy is really one that's sort of in the eye of the beholder. Each new manager can kind of interpret that differently because they have tremendous flexibility in terms of going short duration and making some really bold calls. But you want to see how they actually use that freedom. The current manager has only been there a few months, so we really want to see what he does for a while. But also, the fund hasn't been a great performer. That freedom, so far, has not really been put to shareholders' advantage.

Benz: That whole unconstrained category really hasn't yet delivered fully on what a lot of investors expected it to do.

Kinnel: That's right. Buyer beware with these unconstrained bond funds because they sounded great, but they really haven't quite lived up to the hype.

Benz: Let's turn to funds that have seen big inflows. A lot of bond funds are on this list--and I think that's probably a reaction to what we were just talking about with the big outflows at PIMCO. Investors aren't giving up on fixed income; they're just buying different funds. Toward the top of the list is MetWest Total Return Bond (MWTRX). I assume that that is money coming from PIMCO and going right into that fund?

Kinnel: Exactly. We had a chance to visit both firms back to back in March. It was fascinating because, of course, MetWest is a prime beneficiary. They are getting huge inflows. They are hiring. Things are going great for them. And it makes sense that they would get a lot of that money. It's a firm that was started by ex-PIMCO managers and run in a lot of ways like PIMCO Total Return, though with less-extreme use of derivatives. But they do use a lot of different levers--duration bets, yield-curve bets, sector bets, even some currency. So, it's a lot like PIMCO, only organizationally much more stable. So, it makes sense [that the fund is getting inflows].

So far, the inflows don't seem to have had a big impact, but I definitely think it's worth watching because they don't want to be as derivative-dependent as PIMCO. So, that would imply that there's maybe a lower ceiling on how much they can manage.

Benz: I guess that's a question for you, Russ: I know, in the past, we've said, "Oh, don't worry too much--especially if it's a core bond fund that's seeing big inflows." But are there limits to how large one of these core bond funds can get before you start worrying about performance?

Kinnel: So, I think [that the impact of flows] in a core bond fund, especially at a big organization like MetWest or PIMCO, is much smaller; but over time, it can have a real impact. If you look at even PIMCO Total Return, it used to be able to add more value through issue selection, but as it got bigger and bigger, it was much more about making market calls with derivatives. You can always bet on interest rates falling or this end of the yield curve moving that way or whatever, and so it did change even PIMCO Total Return over time. But it's a much more minor impact than, say, a small- or mid-cap equity fund where it can have a profound impact.

Benz: Dodge & Cox Income (DODIX) is another fund that apparently would seem to be a beneficiary of money coming out of PIMCO Total Return.

Kinnel: That's right. It's obvious why this fund would have appeal. It's been a good performer; it's got a lot more corporates than your typical intermediate-bond fund, but also tremendous stability. Dodge & Cox's people tend to make a career of it. So, if PIMCO's got all of this turmoil, it's understandable [for investors to look at a fund like Dodge & Cox where nothing ever happens]; it's great. Also, they really avoid most of the big, top-down calls; they are much more focused on individual-issue selection. They have a lot of corporates, a lot of mortgages. So, it's a much tamer fund in a lot of ways--not that it doesn't have some credit risk or some interest-rate risk.

Benz: You mentioned individual-issue selection here as well. Presumably, that's something that you and the team are keeping an eye on in terms of these big asset inflows--are they going to force management to change its strategy?

Kinnel: That's right. At all of these funds, you want to watch that very closely. And you can see that in both attribution, on what's driving the fund's performance, and you can see it in the number of holdings; you can see it in whether they are having to move more into derivatives or, say, less in corporates, which is where you typically do issue selection in Dodge & Cox's case. Because they have a big equity team as well, it makes perfect sense that they would do a lot of corporate research. It dovetails nicely with the firm as a whole. So, you definitely want to watch all of that closely.

Benz: PIMCO Income (PONDX), bucking the trend at PIMCO at large, the fund has continued to see pretty big inflows. I know it always has a really fat yield relative to other bond funds--I assume that's part of the attraction--but what else is going on there and how do we rate that fund currently?

Kinnel: That's right. Dan Ivascyn is the manager there, so one of the reasons money is going in is that he's still there. He has owned the record of that fund for a long time; but also, he's now the CIO at the firm, so he has some added responsibilities. But we still have a lot of confidence. We rate the fund Silver. But you're right about the yield; it's a sizable yield, which means they're taking on risk. They've got some credit risk. They've got some foreign bonds as well. So, there are a few different forms of risk. It's a higher-risk fund than PIMCO Total Return, so before you make the switch, understand that you are taking on some meaningful risk. But we rated Silver because we think Ivascyn does a great job with that risk. He has really earned a nice return, produced a nice yield for that risk. So, we have a lot of confidence in Ivascyn and that fund.